Victoria has a son, George, who is seven years old. He has recently been awarded a substantial sum of money due to medical negligence.
Victoria wants to make sure the money is invested in the most appropriate way to support her son. She has heard about personal injury trusts and approaches her adviser to find out what they are and if they can help George.
A personal injury trust is usually set up by a solicitor using payments as a result of an accident, injury or malpractice. The funds are normally paid directly to the solicitor and into the trust so that they are disregarded for the capital means test under legislation.
It is the source of the funds that dictates whether it is a personal injury trust and it may be set up as either a discretionary, interest in possession or bare trust.
The main consideration for using a trust is to protect any “care package” funded by the local authority in order to ensure the capital and income of the trust is not taken into consideration and used up to pay for care.
The trustees can pay for any capital items required by George; for example, a specially adapted home, specialist equipment and replacement household goods. The trustees can also pay for holidays for him and his carers but they will not normally remit “income” directly to his bank account so as not to interfere with his means-tested benefits.
If George is eligible, the trustees may be able to claim special tax treatment in the form of a “vulnerable person election” and the trust will be treated and taxed as a “vulnerable trust”. The trustees can complete form VPE1 and send it to HM Revenue & Customs to enable the trust to benefit from preferential tax treatment if it qualifies.
In order for George’s trust to be deemed as qualifying, its assets must only be capable of being used to benefit George, the disabled person. George must be entitled to all the income; none of the income can be applied for the benefit of anyone else.
Where a trust has a vulnerable beneficiary, the trustees are entitled to a deduction of tax against the amount they would otherwise pay.
To calculate the income tax deduction, firstly the trustees must calculate their income tax liability on the “normal” basis, then calculate the income tax the vulnerable beneficiary would have had to pay if the trust income had been paid directly to George as an individual. The trustees can then claim the difference between these two figures.
Capital gains tax is also payable by the trustees. The CGT relief is worked out in a similar way to income tax relief by calculating the CGT as if there was no relief, calculating the CGT as if the gains arose directly to the vulnerable beneficiary, then claiming the difference between these two amounts.
It should be noted that this special tax treatment does not apply in the tax year in which the beneficiary dies.
Trusts for vulnerable beneficiaries also get special inheritance tax treatment if they are qualifying trusts.
A qualifying trust for a disabled person is one:
- For a disabled person whose trust was set up before 8 April 2013 – at least half of the payments from the trust must go to the disabled person during their lifetime
- For a disabled person whose trust was set up on or after 8 April 2013 – all payments must go to the disabled person, except for up to £3,000 per year (or 3 per cent of the assets, if that is lower), which can be used for someone else’s benefit
- When someone suffering from a condition that is expected to make them disabled sets up a trust for themselves
- For a bereaved minor – they must take all the assets and income at (or before becoming) 18
There is no IHT charge if the person who set up the trust survives for seven years from the date they set it up or on transfers made out of a trust to a vulnerable beneficiary.
When the beneficiary dies, any assets held in the trust on their behalf are treated as part of their estate and IHT may be charged.
Another benefit to using a trust is that normally the trustees have wide investment powers and can invest in any asset that a prudent person would invest in, including bonds, Oeics and bank deposits.
It is also worth noting that trustees can take advantage of the 5 per cent tax deferred withdrawal facility from a life assurance bond under chargeable event legislation. This means only amounts that exceed the allowance will be assessed for tax. This is a very useful facility as trustees can accrue the allowance and use it to take capital out of the bond when it is needed while deferring the tax.
Helen O’Hagan is a technical manager at Prudential